Waddell & Reed Financial, Inc., have released their first quarter results and the news is good. The company's profit climbed 17 percent from last year on gains in its investment management and underwriting and distribution businesses.
Waddell & Reed Financial, Inc. (NYSE:WDR) reported first quarter net income of $28.7 million, or $0.35 per diluted share compared to net income of $30.0 million, or $0.36 per diluted share in last year's fourth quarter and net income of $24.6 million, or $0.30 per diluted share in the first quarter of 2006. Last year's first quarter included a pre-tax charge of $1.9 million ($1.3 million net of tax, or $0.01 per diluted share) related to separation costs at Austin Calvert & Flavin, Inc.
Operating revenues of $189 million increased 2% sequential quarterly and 9% compared to last year's first quarter. The operating margin improved to 24.2% compared to 23.5% and 23.0% for the fourth and first quarters of 2006, respectively. A line-item discussion of our operating results is included below.
Gross sales of $2.4 billion represented a record quarterly level, while net sales remained modestly positive at $26 million. Assets, for the first time in the Company's history, reached $50 billion.
Gross sales in our Advisors channel increased 2% from last year's fourth quarter and declined 7% compared to last year's first quarter. Net sales in the channel were disappointing with outflows of $132 million during the first quarter of 2007. This compares to outflows of $93 million and $6 million for the fourth and first quarters of 2006, respectively. Late in the quarter, we launched two new fee-based asset allocation products which are meeting with strong acceptance by our advisors and showing promising results early in the second quarter. The expected launch of these much anticipated products may have held back sales somewhat in the first quarter.
Advisor productivity increased 6% sequentially and declined 4% compared to the same period last year. The rate of change in productivity differed from the rate of change in sales due to our usual seasonal drop in advisor headcount. We expect to re-engage headcount growth in 2007.
Sales in our Wholesale channel hit an all-time quarterly high at $1.3 billion during the current quarter, increasing 15% compared to $1.1 billion during the fourth quarter and 13% compared to $1.2 billion during the same period last year. Net sales of $704 million during the quarter remain strong and imply a 26% annualized organic growth rate for this channel. Assets under management reached $12 billion.
Outflows rose during the quarter to $546 million compared to outflows of $296 million during the fourth quarter and $278 million during the first quarter of 2006. The increase in outflows stems from higher redemption activity, and resulted in a redemption rate of 48.0%. Redemptions were varied and spread across many investment disciplines, including large cap growth, small cap growth, core equity, and international growth.
"We have made significant progress in diversifying our distribution network and our efforts are beginning to be reflected in our operating margin," said Hank Herrmann, Chief Executive Officer of Waddell & Reed Financial, Inc. "Assets under management reached $50 billion, and provide the scale necessary for us to continue investing for growth and supporting margin improvements over time."
Management Fee Revenue Analysis
On a sequential quarter basis, revenues increased at a lower rate than average assets under management due to two fewer days during the current quarter. The effective management fee rate remained nearly unchanged.
Compared to last year's first quarter, revenue growth was in line with the growth in average assets under management. The effective management fee rate remained nearly unchanged. The fee reduction mandated on certain mutual funds by a regulatory settlement (effective October 1, 2006) was offset by a mix shift in assets under management.
The effective management fee rate during the current quarter was 68.4 basis points, compared to 68.2 basis points and 68.6 basis points in the fourth and first quarters of 2006, respectively.
Underwriting and Distribution Analysis
On a sequential quarterly basis, revenues were essentially flat as higher load and insurance product sales were offset by lower financial planning fees. Direct expenses, which typically correlate to revenues, were lower in the fourth quarter as we adjusted estimates related to compensation tied to production. This resulted in a sequential increase in expenses. Indirect expenses remained almost unchanged.
Compared to last year's first quarter, revenues increased slightly as higher insurance commission and asset-based Rule 12b-1 service fee revenues offset lower load sales commissions. Higher expenses were due in part to higher direct expense costs associated with commissions and Rule 12b-1 payouts. The remainder of the increase is attributable to indirect expenses, namely higher compensation, legal and advertising expenses, and offset partially by lower sales meeting costs.
Sequentially, approximately 75% of the increase in revenues is attributable to higher asset-based Rule 12b-1 service and distribution fees, driven by higher average assets under management. The remainder of the increase is due to higher sales volume at Legend. Direct expenses increased on higher sales volume while indirect expenses declined due to lower travel and marketing costs.
Compared to last year's first quarter, revenues increased largely on higher Rule 12b-1 service and distribution fees and to a lesser extent, higher sales volume at Legend. The increase in expenses is largely attributable to direct expenses, which were driven by higher sales volume, and asset-based Rule 12b-1 service and distribution fee expenses. The increase in indirect expenses was tied to a number of items, including higher marketing, business travel and compensation costs.
Operating Expense Analysis
On a sequential quarterly basis, operating expenses increased slightly. Higher underwriting and distribution expenses (as discussed above) were the primary cause of higher costs. To a lesser extent, higher subadvisory expenses also contributed to the increase in costs. Partially offsetting these cost increases were lower compensation and related costs. Our fourth quarter results included higher costs for bonus accruals, which resulted in a sequential cost decline.
Compared to last year's first quarter, costs increased primarily on higher underwriting and distribution costs (as discussed above) and to a lesser extent, higher subadvisory costs. Partially offsetting this increase were lower compensation costs. Last year's first quarter included a $1.9 million charge for employee separation costs at ACF and an after-tax addition to net income of $321 thousand to recapture the cumulative effect of the implementation of SFAS 123R "Share-Based Payment, (revised 2004)".
The 2007 annual restricted stock grant resulted in the issuance of an additional 1.1 million shares of restricted stock. These shares, like those issued in previous years, will vest on a straight line basis over the next four years.
For the quarter ended March 31, 2007, subadvised average assets under management were $8.7 billion, compared to $8.4 billion and $6.1 billion for the fourth and first quarters of 2006, respectively.
Investment and other income was lower in the first quarter of 2007 compared to fourth quarter 2006 due to a reduction in capital gain and dividend distributions, and recognized gains from sales in our mutual fund investment portfolio. Compared to last year's first quarter, investment income was slightly higher due mainly to higher earnings on cash balances.
Our effective income tax rate for the first quarter of this year was higher when compared to fourth quarter 2006 due to state incentives recognized in our fourth quarter tax provision. There were no state tax incentives recognized in this year's first quarter; however, we do expect to recognize additional state incentives based on future capital spending. The adoption of FIN 48 "Accounting for Uncertainty in Income Taxes," had little impact on our effective rate in the first quarter.
Balance Sheet Information
Cash and cash equivalents and investment securities are $229 million (including $40 million held for the exclusive benefit of customers in compliance with federal securities industry regulations). We have no short-term outstanding borrowings against our money market loan program or our $200 million credit facility.
Stockholders' equity is $229 million and there are 83.3 million shares outstanding. During the quarter, we repurchased 1,465,000 shares of common stock in the open market at an aggregate cost of $38.8 million.
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